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Understanding China’s Economic and Market Developments: Managing China’s Transition Into Global Benchmarks [Document subtitle, 13.5pt, white or burgundy] 2018 | ftserussell.com

FTSE Russell | Understanding China’s Economic Development: Opportunities and Challenges for International Investors

2

Executive Summary

Since the introduction of economic reforms some 40 years ago, China’s

economy has metamorphosed into a formidable driver of global growth as it

opens its market to international investors.

This growth has been driven by decades of policy and economic reforms

that has transformed its economy into the second largest in the world.

Its achievement has been based on political stability and long-term reforms

that have urbanized its vast population to drive its expansionary policies

into manufacturing and export-orientated growth.

Large investment in infrastructure and expansion of its cities have

supported the migration of its workforce, although an aging population and

a growing, wealthy middle class have shifted focus towards automation,

robotics and a service-based economy.

China's focus on economic growth has been at the cost of high levels of air,

water and soil pollution which has spurred growth in environmental

initiatives supported by government subsidies and investment

opportunities.

State-owned companies have consolidated in support of the shift in

economic policy. This has led to a spotlight in how companies are

managed, on corporate governance and the adoption of international

accounting principles.

Stock exchanges and regulators are driving change to listing requirements

as well as the way companies report. Regulators have opened the door to

international institutional investors to access equities and the China

Interbank Bond markets. They have expanded the Stock Connect scheme

to include the Shanghai and Shenzhen Stock Exchanges and opened Bond

Connect.

All these developments provide opportunities to international investors as

they look to diversify their exposure to a market where the majority of

investors have historically had no access.

FTSE Russell continues to support these investment choices via years of

experience in the mainland China market. As the first international index

provider of mainland Chinese benchmarks and an index product suite that

demonstrates the breadth and depth of China's equity/bond markets, FTSE

Russell leads the way in providing solutions to our clients' needs.

As a result of recent enhancements, China A Shares (available through the

‘Northbound’ Stock Connect route) will be assigned as Secondary

Emerging and will join the FTSE Russell’s global equity benchmarks in

June 2019.

China A Shares

(available through the

‘Northbound’ Stock

Connect route) will be

assigned as Secondary

Emerging and will join

the FTSE Russell’s

global equity

benchmarks in June

2019.


3

For fixed income, FTSE Russell has recently completed a market

consultation on a proposal to establish a transparent and evidence-driven

country classification framework for the FTSE global fixed income

benchmarks. It will calibrate an annually-reviewed “Market Accessibility

Level” for local currency government bond markets.

As within the equity framework, a Watch List of countries on the cusp of

reclassification will be published and maintained. China government bonds

will be added to this Watch List and assessed against the stated criteria of

the framework for possible inclusion in the flagship investment grade FTSE

World Government Bond Index.

Historic reforms drive China's economic transformation

1978: Economic reforms introduced by Deng Xiaoping: the Third Plenary Session of the

11th

Central Committee of the Communist Party lays the groundwork for future growth.

1979: The Law on Chinese Foreign Equity Joint Ventures allows foreign capital to enter

the country, boosting regional economies.

1980: The Chinese government permits companies to retain profits and set up their own

wage structures, increasing GDP and the pace of urbanization. Shenzhen becomes the

first 'special economic zone'.

1990: The Shanghai stock market reopens for the first time since 1949.

1991: The Shenzhen stock exchange opens.

1996: Renminbi becomes a convertible currency.

2001: China joins the World Trade Organization leading to a deeper integration into the

world economy.

2002: Qualified Foreign Institutional Investor (QFII) scheme launches.

2005-2006: Non-tradable share reform which increased the number of shares available

to trade and reduced government ownership of listed shares - prior to reforms non-

tradable shares accounted for 64% of total shares outstanding*.

2006: Qualified Domestic Institutional Investor (QDII) scheme launches.

2011: Renminbi Qualified Foreign Institutional Investor (RQFII) scheme launches.

2014: Shanghai/Hong Kong Stock Connect scheme launches.

2016: IMF adds renminbi to SDR basket, Shenzhen Stock Connect launches, AIIB

launches.

2017: Bond Connect scheme launches.

2019: Inclusion into the FTSE Russell global equity benchmarks.

Sources: *CSRC, February 2007 and https://www.weforum.org/agenda/2015/07/brief-history-of-china-

economic-growth/

FTSE Russell has

recently completed a

market consultation on

a proposal to establish a

transparent and

evidence-driven country

classification framework

for the FTSE global

fixed income

benchmarks.

With over 16 years of

experience developing

China market indexes,

FTSE Russell’s China

benchmarks have

become widely

recognized by investors

and ETF issuers

globally as a leading

measure of the China

equity market.

https://www.weforum.org/agenda/2015/07/brief-history-of-china-economic-growth/

https://www.weforum.org/agenda/2015/07/brief-history-of-china-economic-growth/


4

Contents

1. Old to New – China's Giant Steps ...................................................... 5

2. Chinese equity markets: a mirror on ‘New China’ .......................... 16

3. China is adapting its corporate governance framework ................ 19

4. The opportunity set: access to China's domestic market .............. 22

5. Rising star – China's fixed-income market ...................................... 29

6. Foreign investor access to the Chinese onshore bond market ................................................................................................ 34

7. China is opening its equity market to international investors ....... 38

8. FTSE Russell's approach to managing China's transition into global benchmarks .................................................................... 40

9. Appendix ............................................................................................ 48


5

1. Old to New – China's Giant Steps

Since the introduction of economic reforms some 40 years ago, China's economy

has metamorphosed into a formidable driver of global growth. From a largely

agrarian society, the country has evolved into a manufacturing powerhouse and

is transitioning under President Xi's guidance into a high-end, service-based

economy.

China is the second largest G20 economy behind the United States (Chart 1).

Chart 1: China a leader among G20 economies

Source: FTSE Russell and Thomson Reuters Datastream, December 2017.

China has owed its rapid expansion to decades of policy and economic reforms,

the openness of its markets to attract international capital, strong exports and the

substantial urbanization of its society. The country gained from its status as the

manufacturing hub of the developed world where companies set up assembling

plants for re-exports by taking advantage of lower labor costs.

This resulted in one of the largest work-migrant transfers in recent history as rural

migrants, in search of a better life, moved to cities, fueling the country's

spectacular economic boom. To house the growing number of workers, hundreds

of new cities were built or expanded, requiring large investment in infrastructure.

At the beginning of Deng Xiaoping's economic reforms in 1978, about 18% of the

Chinese population lived in urban areas. By 2018, this figure had risen to 57.9%1

and is forecast to approach 80% by 2050, according to United Nations estimates

(Chart 2).

1 Source: Worldometer: http://www.worldometers.info/world-population/china-population/

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

20,000

Un

ite

d S

tate

s

Ch

ina

Japa

n

Germ

any

Un

ite

d K

ing

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Fra

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India

Ita

ly

Bra

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Ca

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Spain

Austr

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Me

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Indon

esia

Turk

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Ne

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and

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Sw

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and

Saud

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rabia

G20 Countries Nominal GDP (USD, billions)

57.9% Chinese live in

urban areas; United

Nations estimates this

to rise to 80% by 2050.

China is the second

largest G20 economy

behind the United

States.

http://www.worldometers.info/world-population/china-population/


6

Chart 2: China has rapidly urbanized during the past 50 years

Source: United Nations, 2018.

Transitioning to a service-based economy

By the mid-2000s, China saw its economic dependency on heavy industries

diminish as it moved up the value chain and embraced new technologies. As

living standards improved and salaries increased, Chinese industries shifted

focus towards automation, robotics and a new service-based economy.

Chart 3: A new service-based economy emerges from mid-2000s

Source: FTSE Russell and Thomson Reuters as at June 30, 2017.

0

10

20

30

40

50

60

70

80

1970 1980 1990 2000 2010 2020 2030 2040 2050

Urban Population (%)

% Urban Population

0

10

20

30

40

50

60

1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 2012 2017

China GDP by Industry (%)

Industrial Agriculture Services

Improving living

standards increases

focus on automation,

robotics and a new

service-based economy.


7

Today China aims to become a High-Income economy an increase from its

Upper-Middle Income level currently, based on the World Bank's GNI per Capita

Rating in 2017. The country's per capita gross national income (GNI) has more

than quadrupled since the mid-1990s, but it is still significantly below that of

some Asian economies. China's GNI per capita is US$8,250, compared to

US$27,600 for South Korea and US$37,930 for Japan (Chart 4).

On a relative percentage basis, China’s per capita GNI is only 11.3%2 of that of

the United States with large parts of the country still resembling the early stages

of economic development seen in South Korea and Japan for example.

Chart 4. The long road: China economic journey

Source: FTSE Russell, Thomson Reuters and the World Bank GNI Per Capital Rating as at June, 30 2017.

As its economy becomes more mature, China's growth rate is on a trajectory to

grow by a more sustainable 6% per annum. In 2017, the country's GDP grew by

6.9%3 driven by private consumption and investment growth.

2 Source: World Bank (January 1998−January 2018)

3 http://www.imf.org/External/spring/2018/imfc/statement/eng/chn.pdf

0

10

20

30

40

50

60

70

1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 2012 2017

GNI Per Capita (USD, World Bank Atlas Method)

United States China Japan South Korea

High Income: Above $12,236

Upper-Middle Income: $3,956-$12,235

Lower-Middle Income: $1,906-$3,955

Low Income: Below $1,005

The opportunity: China’s

GNI is still significantly

below that of some

Asian countries but the

country aims to become

a High-Income

economy.


8

Chart 5: Chinese growth has slowed from teens to single digit


China and the US have been the dominant contributors to global GDP growth

since 2012, offsetting negative growth elsewhere in the world (Chart 6). Should

China's role as a growth driver diminish, what will the impact be for the world

economy? The Chinese government has taken numerous steps to offset slowing

growth, including a middle-class tax cut aimed at stimulating consumer spending

following a fall in retail sales. The central bank has also cut the reserve

requirement ratio for lenders several times during 2018, amid concerns over

market liquidity and the potential impact from a trade dispute with the US.

Chart 6: China has been a main contributor to global growth since 2012

Source: World Bank and FTSE Russell, as at December 31, 2017.

4

6

8

10

12

14

16

1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018

China Real GDP Growth (%)

GDP (ex Hong Kong and Macau)

-2,000

-1,000

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

World China US Eurozone Brazil Japan

Expansion of GDP 2012-2017 (USD, Bn)

The Chinese

government has taken

numerous steps to

offset slowing growth.


9

China's actions reverberate worldwide

China's significant contribution to the world economy means that its actions can

have unexpected consequences beyond its borders. One instance was when the

authorities unilaterally took actions to depreciate the yuan in August 2015 to

make it more competitive on the back of a slowing economy. The move impacted

currency, fixed income, equity and commodity markets globally (Chart 7).

Chart 7: The fall in Chinese equity market affected global stock markets

Source: FTSE Russell as at September 1, 2018. Past performance is no guarantee of future results. Returns

shown prior to index launch reflect hypothetical historical performance. Please see the end for important legal disclosures.

The Chinese authorities promptly restored confidence by successfully stepping in

to defend the renminbi using their foreign exchange reserves and enacting

several measures to stem the tide of turbulence such as cutting interest rates,

buying equities, halting initial public offerings and limiting capital outflows and

short selling. A similar effort of currency intervention was implemented during

2018 as trade tensions with the United States intensified.

Chart 8: Contraction of foreign exchange reserves has stabilized

Source: FTSE Russell and Thomson Reuters as at July 31, 2018.

0

50

100

150

200

250

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

FTSE China All Cap Inclusion vs FTSE Global All Cap TR (USD, Rebased)

FTSE China All Cap Inclusion Index FTSE Global All Cap Index

0

1000

2000

3000

4000

5000

China FX Reserves (USD, billions)

Foreign Reserves

China's significant

contribution to the world

economy means that its

actions can have

unexpected

consequences beyond

its borders.


10

For much of the past two years, the yuan has appreciated against the US dollar

but an escalation in trade tensions during 2018 reversed the trend prompting a

sharp devaluation of the Chinese currency (Chart 9).

Chart 9: The yuan has taken the brunt of China-US trade tensions

Source: FTSE Russell and Thomson Reuters as at August 30, 2018.

Despite China's attempts to diversify its large foreign reserves and

internationalize the yuan, the US Treasury market (US$15.7 trillion)4 has

remained the only relatively low risk market which is liquid enough to provide

China with investible assets for its large foreign reserves. Most of those reserves

- around US$2 trillion - are held in US dollars, of which about US$1.2 trillion

today is invested in US Treasuries5, some 37% of China's total foreign exchange

reserves (Chart 10).

4 Source: US Treasury website; https://www.treasurydirect.gov/govt/reports/pd/pd_debttothepenny.htm, as at August 30, 2018

5 http://ticdata.treasury.gov/Publish/mfh.txt, June 2018

5.8

6.0

6.2

6.4

6.6

6.8

7.0

7.2

Aug-08 Aug-09 Aug-10 Aug-11 Aug-12 Aug-13 Aug-14 Aug-15 Aug-16 Aug-17 Aug-18

Chinese Yuan to USD

Yuan to USD

Some 37% of China’s

total foreign exchange

reserves are held in US

Treasuries.

https://www.treasurydirect.gov/govt/reports/pd/pd_debttothepenny.htm

http://ticdata.treasury.gov/Publish/mfh.txt


11

Chart 10: China is the single largest foreign owner of US government debt


Headwinds: China's heavy debt burden

However, China's high debt level has become a notable headwind for the

country's economic growth plans. The sheer size grew out of the large build-up of

debt in the non-financial corporate sector as the Chinese authorities flooded the

market with liquidity to stimulate the economy in the aftermath of the global

financial crisis.

The government combined cuts in short-term interest rates with a reduction in its

banks' reserve requirement ratio to encourage lending to state-owned enterprises

(SOEs). This fostered unprecedented demand, not only for corporate, but also for

household borrowing.

In January 2018, the International Monetary Fund (IMF) warned of the financial

risk posed by the credit growth outpacing GDP growth if left unchecked and

called for the need to deflate the 'credit boom'.6 Household debt, while still

comparatively low, has also been rising (Chart 11).

6 IMF Working Paper, Credit Booms – Is China Different, Sally Chen and Joong Shik Kang

20

25

30

35

40

45

50

1999 2001 2003 2005 2007 2009 2011 2013 2015 2017

Chinese Holdings of US Treasuries % of FX Reserves

China has a high debt

level which has become

a notable headwind for

the country's economic

growth plans.


12

Chart 11: Non-financial corporations debt is responsible for China's debt

problem

Source: FTSE Russell and Thomson Reuters as at December 30, 2017.

Between 2006 and 2017, China became one of most indebted countries in the

world after Japan (Chart 12) as its non-financial corporate debt rose from 146%

to 255% of GDP (Chart 11).

Chart 12: China joins Japan as the most indebted countries in the world

Source: FTSE Russell and Thomson Reuters as at December 30, 2017.

0

50

100

150

200

250

300

350

400

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

China Debt to GDP by Sector (%)

Non-Financial Corporations Government Households Total Debt

50

100

150

200

250

300

350

400

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Total debt to GDP

China United States Japan Eurozone Developing Countries


13

To support growth, the authorities increased their lending to state-owned

enterprises and for a while, their output soared and profits grew. Over time

however, it created overcapacity and misallocations of capital, especially in

sectors such as steel, cement, solar, shipbuilding, heavy machinery and mining.

Cheap loans also ignited a housing boom, boosting the construction sector and

sending real estate prices higher (Chart 13).

Chart 13: Easy credits fueled housing bubble

Source: FTSE Russell and Thomson Reuters as at July 31, 2018.

The non-performing loans dilemma

For years international investors have viewed Chinese banks' official non-

performing loan (NPL) ratios with concern, amid suspicion that banks were using

loan rollovers or off-balance-sheet accounting - known as shadow banking - to

disguise the extent of their credit losses.

Shadow banking explained

Shadow banking involves the creation of off-balance sheet assets via

wealth management (WMP) and trust products that are sold by banks and

non-bank financial institutions. WMPs and trusts promise higher fixed

returns compared to bank deposits and generally have short maturities.

Proceeds from these products are usually invested in the mainland bond

and equity markets where, due to their short maturities (maturity

mismatching) and leveraged trading, investments tend to have rollover and

principal risks7.

7 Source: https://geopoliticalfutures.com/china-gets-serious-financial-reform/)

-2

-1.5

-1

-0.5

0

0.5

1

1.5

2

2.5

3

-10

-5

0

5

10

15China House Prices (70 medium & large cities)

Monthly % (LHS) Yearly % (RHS)

Cheap housing loans

ignited a housing

bubble.


14

The Chinese authorities are implementing measures to address the non-

performing loans (NPLs). In 2008 at the height of the Global Financial Crisis, the

average NPL rate had declined significantly as the Agricultural Bank of China

transferred most of its NPLs to its asset management companies.8 In 2016, the

former banking regulator, the China Banking Regulatory Commission (CBRC),

enforced one of the highest coverage-ratio provisions by requiring commercial

banks to adopt a range of 120%-150% to curb lending. This helped drive the ratio

of NPLs as a percentage of total loans from over 10% to around 2%. However,

during 2018 the number of bad loans from real estate has risen as part of

regulator's clamping down on risks in the financial sector9 (Chart 14).

Chart 14: Chinese authorities have been tackling the non-performing loans


Even so, given China's size in the world economy, the IMF in a January 2018

working paper raised its concerns about the country's systematic risks and the

impact it could have on the global economy due to its growing influence.10

Headwind: Will China get old before it gets rich?

Aging population is another potential impediment to China's economic growth.

The government's imposition of strict controls on family size (One Child Policy)

between 1980 to 2016 significantly increased the proportion of its elderly

population (Chart 15). As a consequence, the working age population (those

aged 15-64) started to decline in 2014.11

China's dependency ratio (the

difference between those not in the labor force with those who are working) could

also rise to 44%12

by 2050, causing further challenges.

8 Source: https://geopoliticalfutures.com/chinas-problem-with-non-performing-loans/

9 Bloomberg, https://www.bloomberg.com/news/articles/2018-07-03/chinese-bank-s-capital-almost-wiped-out-as-loan-rules-tightened

10 IMF Working Paper: Credit Booms-Is China Different? By Sally Chen and Joong Shik Kang, January 2018

11 National Bureau of Statistics of China: http://data.stats.gov.cn/english/easyquery.htm?cn=C01

12 United Nations

-60

-50

-40

-30

-20

-10

0

10

20

30

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Value of Chinese Non-Performing Loans (Qly % Change, CNY)

China’s working

population is decreasing

to such an extent that it

could become a

potential impediment to

its economic growth.

The Chinese authorities

are implementing

measures to address

their non-performing

loans problem.


15

The Chinese authorities have been exploring ways to reduce the problem.

Among the ideas being considered are lifting family-size limits, raising the

retirement age from 60 years for men, 55 for female (white-collar workers) and

50 for female blue-collar employees and improving the health care system.

Chart 15: China's worker to retiree ratio is sharply falling

Source: United Nations, September 2018.

23.5 22.3 18.7

66.9 63.5 55.0

9.7 14.2 26.3

0

20

40

60

80

100

2015 2025 2050

China % Population by Age Group

0-19 20-64 65+


16

2. Chinese equity markets: a mirror on ‘New China’

As China's economy transformed so did the size and the make-up of its equity

market. Home to three of the world's 10 largest stock exchanges (Shanghai and

Shenzhen in Mainland China and Hong Kong), China's domestic equity market is

the second largest in the world with a market capitalization of about US$9

trillion.13

Chart 16: Market-capitalization of domestic listed companies in 2017

(USD trillion)

Source: World Bank as at December 29, 2017.

New Chinese sectors are displacing old ones

Healthcare, technology, consumer-related sectors, education, entertainment and

financial services have gained market share during the last 10 years at the

expense of heavy industries, oil and gas and basic materials.

China has rapidly automated its manufacturing industry and today dominates the

production of most consumer electronics and a large share of industrial

electronics. Called the "robot revolution" the country owns the highest stock of

industrial robots globally, consuming 30% of the world's total supply of robots in

2016, as China looks to offset rising labor costs and the beginning of a falling

labor force.14

Renewable energy is another important sector in which China has made

significant investments. High levels of air, water and soil pollution had spurred

the Chinese government to heavily invest in environmental initiatives. In 2017,

Chinese investments accounted for 45% of the global total.

13

Worldbank.org as at December 29, 2017 14

IFR.org as at December 2016, https://ifr.org/downloads/press/Executive_Summary_WR_2017_Industrial_Robots.pdf

0

5

10

15

20

25

30

35

United States China Euro area Japan

Healthcare, technology

and financial and

consumer services have

gained market share

during the last 10 years.

China's domestic equity

market is the second

largest in the world.

https://ifr.org/downloads/press/Executive_Summary_WR_2017_Industrial_Robots.pdf


17

Within a broad green economy universe15

of some 3000 companies, China now

represents 12% of the market with both the number of green companies and their

green revenues exposure outpacing many other nations.

Chart 17: China has become a significant participant in the green economy.

Source: FTSE Russell, December 2017

China is uniquely placed in that it has become a global market-leader in the

production of solar panels and is rapidly taking market share in the manufacture

and adoption of electric vehicles. China was one of the fastest growing markets

for plug-in electrical vehicles in Q1 2017.16

Domestically, China is also recognized as the largest installer of renewable

energy. However the cost of renewable projects, which have been heavily

subsidized by the Chinese government, have added to the country's existing high

debt levels and resulted in the oversupply of solar energy.

To limit waste and reduce costs, the authorities have introduced alternative

schemes. For example, recent projects have included setting capacity limits in

regions with high waste rates, launching a nationwide carbon emissions trading

market and issuing via the China National Renewable Energy Centre green

electricity trading certificates.

15

FTSE Russell paper, Investing in the global green economy: busting common myths on FTSErussell.com 16

Source: EV-volumes.com as at Q1 2017, http://www.ev-volumes.com/country/total-world-plug-in-vehicle-volumes/

United States 43%

Japan 13%

China 12%

Germany 4%

Taiwan 4%

France 3%

Other 21%

Green economy by country of domicile

China represents 12%

of the green economy

universe.

China is the global

leader in solar panels

production.


18

Chart 18: Over the last 10 years, China has diversified across a broader

section of industries

Source: FTSE Russell as at August 31, 2018.

Although financials are gradually losing their market dominance to the faster

growing technology sector, they still represent a significant portion of the equity

market, especially in financial services where new opportunities are opening up.

China's demographics will change the future national reallocations of resources

and priorities as more funds are expected to flow to health care, pensions and

insurance with existing and newly formed financial institutions (as the industry

and services move online) lying at the heart of this structural change. Further

reforms to the banking, securities, futures, asset management and insurance

sectors are opening up these areas to foreign investment, therefore increasing

choice and competition.

The country's pension system will need to further develop to avoid a large

funding gap and meet the needs of an aging population. Occupational pensions

(through the Enterprise Annuity system) and private pensions for individuals are

still in their infancy with most Chinese dependent on the government-run

schemes the Public Pension Fund (PPF) and the National Council for Social

Security Fund (NCSSF). Substantial regulatory progress have already been

made. Asset managers are now able to pitch for external allocations from the

state-run pension funds. The enterprise annuity market is adopting a hybrid

system, where both employers and employees contribute and gradually open it

up to foreign companies and for individual retirement accounts. The State

Council is introducing a pilot tax deferred pension plan and promoting elderly

endowment insurance17

. In doing so, it would provide an opportunity for an

important shift into occupational or private pension savings in the future and pave

the way for China to become one of the world's most dynamic pension markets.

17

KPMG, https://assets.kpmg.com/content/dam/kpmg/cn/pdf/en/2017/12/china-pension-outlook.pdf

05

10152025303540

FTSE China Intl All Cap Inclusion (no Quota) Industry Weight (%)

10 Years Ago 5 Years Ago Current

China's demographics

will change the future

national reallocations of

resources and priorities

as more funds are

expected to flow to

health care, pensions

and insurance.


19

3. China is adapting its corporate governance framework

The corporate governance framework in China is developing and adapting as the

country's economy transforms. Stock exchanges and regulators are driving

changes to the listing requirements as well as the way companies report. A large

part of this change is via state-owned enterprises (SOEs), which are regulated by

the State-Owned Assets Supervision & Administration Commission (SASAC).

This oversees some US$30 trillion in government assets. 18

In recent years, the government has increased the pace of its reform of the

financial industry as it seeks to internationalize its economy and business

practices. In 2015, the authorities unveiled a comprehensive plan to establish a

modern enterprise system and management system under the State Council

blueprint for state-owned enterprise consolidation.19

As a result, SOEs have been

consolidating, bringing a new generation of more-entrepreneurial managers to

run them more efficiently, shutting down loss-making 'zombie' companies and

encouraging private capital.

Until recently, the oversight of securities, banking and insurance had been under

different regulators. This had created a fragmented financial regulatory structure.

To better address financial risks (i.e. the large debt levels of SOEs), China's

State Council created in 2017 a super regulator, the Financial Stability

Development Committee, to coordinate the supervision and management of

financial stability. At the same time, China's central bank, the People's Bank of

China (PBOC), was given a larger role with new powers to exercise

macro-prudential regulation and safeguard against systemic risks.

The China Securities Regulatory Commission (CSRC) and the State

Administration of Foreign Exchange (SAFE) have remained separate regulators.

Their role is to continue the pace of reform and open the domestic stock markets

to global investors.

As more global investors consider investing in Chinese equities, these efforts

have put a spotlight on how companies are managed and their adoption of

standard accounting principles20

and corporate governance.

Accounting principles are aligned to international standards

Chinese authorities have adopted their version of International Financial

Reporting Standards (IFRS) in 2006 to align them with global standards. The

convergence of Chinese accounting rules into international accounting standards

has been an important step towards China's continuing integration into the world

economy. Depending on their specific circumstances, companies are required to

implement the appropriate accounting standard as follows:

18

Size and Sectoral Distribution of State-Owned Enterprises:

https://www.oecd.org/industry/ind/Item_6_3_OECD_Korin_Kane.pdf 19

https://www.linklaters.com/en/insights/publications/asia-news/asia-corporate/2018/chinas-state-council-kickstarts-market-for-prc-listed-depositary-receipts-for-overseas-listed-shares 20

https://www2.deloitte.com/cn/en/pages/risk/solutions/cg-governance-profile.html)

Stock exchanges and

regulators are driving

changes to the listing

requirements as well as

the way companies

report.

https://www.oecd.org/industry/ind/Item_6_3_OECD_Korin_Kane.pdf

https://www.linklaters.com/en/insights/publications/asia-news/asia-corporate/2018/chinas-state-council-kickstarts-market-for-prc-listed-depositary-receipts-for-overseas-listed-shares

https://www.linklaters.com/en/insights/publications/asia-news/asia-corporate/2018/chinas-state-council-kickstarts-market-for-prc-listed-depositary-receipts-for-overseas-listed-shares

https://www2.deloitte.com/cn/en/pages/risk/solutions/cg-governance-profile.html


20

All publicly listed Chinese companies which trade in China are required

to use Chinese Accounting Standards for Business Enterprises (ASBEs)

for financial reporting within mainland China.

Chinese companies, whose securities trade on the Hong Kong Stock

Exchange, can choose between IFRS Standards, Hong Kong Financial

Reporting Standards (HKFRS) and ASBEs for the purposes of financial

reporting to Hong Kong investors.

Where international and Chinese accounting rules can differ is in the

treatment of 'related party' accounting. The International Accounting

Standard Board requires entities to disclose in their financial statements

information about transactions with related parties. However, state-

owned enterprises have a partial exemption for 'related party' disclosures

due to the large ownership of government enterprises situated off-

balance sheet.

The formulation and implementation of regulatory provisions has greatly

promoted the corporate governance reform process and facilitated the

improvement of the corporate governance level of listed companies in the areas

of independent directorship; information disclosure; interest related party

transaction; general shareholders' meeting; merger and acquisition;

reorganization; and investor protection.

Shareholder rights today are similar to other markets

The Company Law of the People's Republic of China (PRC Company Law)

provides many of the rights and protections for shareholders:

Shareholders have the right to attend and vote at shareholder meetings

(via one share, one vote principle).

Shareholders are entitled to dividend payments and to liquidation of

proceeds in the event of bankruptcy.

Shareholders can appoint a candidate as an independent director for

shareholders who hold 1% or more shares of a listed company.

No fewer than one-third of the board of directors of a listed company

should be independent directors.

Shareholders are to be treated equally in the event of a takeover.

When an investor's shareholding reaches 5% of the issued shares of a

target company the investor is required to disclose their position.

However, foreign investors should be aware of existing limitations:

The PRC Company Law only provides for common shares and to date

does not include preferred stock, deferred stock or golden shares. Hence

in practice, there are no meetings for certain classes of shareholders.

Article 104 of the Company Law provides that each shareholder is

entitled to one vote per share.

The Company Law of

the People's Republic of

China (PRC Company

Law) provides many of

the rights and

protections for

shareholders.


21

There are regulatory oversight differences between A Share (mainland

China) and H Share (Hong Kong) listings, in some cases for the same

company, contributing to extra layers of risk and complexity.

Companies employing variable interest entity (VIE) governance

structures are often tilted to favor the founder and ownership risk is

increased due to legal uncertainties.

Many Chinese companies have a degree of direct and/or indirect state

ownership.

The overall foreign ownership is limited to 30% for most companies.

China's Variable Interest Entity (VIE) structure in brief

VIE is a structure in which an investor has a controlling interest which

is not based on a majority of voting rights. To achieve the initial public

offering, Chinese companies can opt for an offshore-listing structure,

which allows foreign investors access to Chinese companies in

'restricted' industries (i.e. Internet).

More than one hundred Chinese companies have adopted the VIE

structure for their offshore listings. Examples include well-known

technology companies such as, Alibaba, Tencent and Baidu.

International investors should inform themselves of the potential risks of

investing in VIE structures, some of the which are as follows:

Offshore holding companies can lose control over domestic

companies within the structure.

Changes to founder, senior management or shareholder of the

domestic company, could affect the life of the structure.

The reputation and equity commitment held by the founder is key to

the company's success.

The structure may not be compliant with PRC law, posing risks to

settlement of disputes.

The incorporation in the Cayman Islands (utilizing the CI 'Exempt

Companies' provisions) means an absence of legal requirements to

hold AGMs and an excessively high request threshold for calling an

EGM.

Source: China Law Insight21

21

https://www.chinalawinsight.com/2012/02/articles/corporate/foreign-investment/variable-interest-entity-structure-in-china/

Many Chinese

companies have a

degree of direct and/or

indirect state ownership.

https://www.chinalawinsight.com/2012/02/articles/corporate/foreign-investment/variable-interest-entity-structure-in-china/


22

4. The opportunity set: access to China's domestic market

China has historically been a difficult market to access for foreign investors. Up

until 2002, international institutional investors aiming to enter China had to be in

a joint venture with a local Chinese equivalent. Since then, regulators have

opened the door to overseas investors to access the China A Share market and

the China Interbank Bond Market.

Although investors can gain exposure to China through overseas listings, the

domestic A Share market accounts for the majority of the China equity

opportunity set. The table below provides an overview of the different types of

shares available to Chinese and foreign equity investors.

Table 1: Guide to Chinese Share Classes and where there are traded

Shares Class

Country of Incorporation

Country of Listing Country of Listing

Currency of Listing

Open to Chinese Investors

Open to Foreign investors

A Share China China Chinese companies incorporated on the Mainland traded on the domestic Shanghai and Shenzhen exchanges.

RMB Yes Yes

via QFII, RQFII and Stock Connect schemes.

B Share China China Chinese companies incorporated on the Mainland and traded in Shanghai and Shenzhen exchanges.

USD (Shanghai), HKD (Shenzhen)

Yes with foreign currency dealing accounts.

Yes

H Share China Hong Kong Chinese companies incorporated on the Mainland and traded in Hong Kong (HKEX). The majority of companies have an associated A- share listing.

HKD Yes if QDII approved or under Stock Connect Schemes.

Yes

Red Chip Outside China Hong Kong State-owned Chinese companies incorporated outside the Mainland and traded on HKEX.


Yes

P Chip Outside China Hong Kong Private Chinese companies incorporated outside the mainland (Cayman Islands, Bermuda) and traded in HK (HKEX).


Yes

S Chip Outside China Singapore Chinese companies incorporated outside the mainland (Cayman Islands, Bermuda) and traded in Singapore (SGX).

SGD/USD Yes if QDII approved.

Yes

Regulators have

opened the door to

overseas investors to

access the China A

Share market and the

China Interbank Bond

Market.


23

Shares Class

Country of Incorporation

Country of Listing Country of Listing

Currency of Listing

Open to Chinese Investors

Open to Foreign investors

N Share Outside China United States (New York-listing)

Chinese companies incorporated outside the mainland (Cayman Islands, Bermuda) and traded in the USA on NYSE or NASDAQ.

USD Yes if QDII approved.

Yes

L Share Outside China United Kingdom

Chinese companies incorporated outside the mainland (Cayman Islands, Bermuda) and traded on the London Stock Exchange (LSE).

GBP Yes if QDII approved.

Yes

Chinese depositary receipt (CDR)

A new route for Chinese companies to list back on the mainland China equity

market is via Chinese depository receipts (CDRs). The authorities have offered

CDRs to some of its biggest and fastest growing companies, many of which had

listed overseas to avoid the legal and technical barriers to a mainland listing as

well as to gain access to international investors and bond markets.

China Depositary Receipt

China’s depository receipts are a certificate issued by a custodian bank

that represents a pool of foreign equity that is traded on Chinese

exchanges. Chinese regulators have modelled CDRs after US-listed

American depositary receipts so that overseas stocks could be traded on

China's mainland market. The goal of issuing CDRs is to entice capital

back to the Chinese market to drive the economy as China's technology

giants have traditionally opted to list outside their home market.

The issuance of CDRs allows both Chinese institutional and private

investors to own shares in Chinese foreign-listed companies.


24

Main entry routes to China A Shares for foreign investors

There are three main points of access which can be used by foreign investors:

The Qualified Foreign Institutional Investors (QFII), the Renminbi Qualified

Foreign Institutional Investor (RQFII) and the Connect schemes. Each provides a

mechanism for foreign investors to invest in one of the largest global markets.

Using the current access points, to date international institutional investors

represent only 2.3%22

of the China A Share market.

Chart 19: Timeline of access schemes for international investors

Qualified Foreign Institutional Investor (QFII) and other arrangements

The Qualified Foreign Institutional Investor scheme has historically been the

primary channel to access China, although the Connect schemes have now

become a popular route for international investors.

Introduced in December 2002, QFII allows institutional investors who meet

certain requirements to directly invest on both the Shanghai and Shenzhen

exchanges. Foreign investments in China are restricted due to foreign exchange

control; the quota, products, accounts and fund conversions are strictly

monitored and regulated.

22

FTSE Russell paper, data as at March 29, 2018 – Embracing China’s economic shift through the Total China Concept

2002 2011 2013 2014 2015 2016 2017

2002

Qualified Foreign Institutional Investor (QFII) Scheme

2011

Renminbi Qualified foreign Institutional Investor (RQFII) Scheme

2013

Qualified Domestic Limited Partnership

2014

Shanghai-Hong Kong Connect

Scheme

2015

Mutual Recognition of Funds

Scheme

2016

Shenzhen Stock Connect & China Interbank Bond Market Access Scheme

2017

Bond Connect Scheme

Connect schemes are

the newest and most

flexible entry points to

China's domestic equity

(Stock Connect) and

bond (Bond Connect)

markets for foreign

investors.

Foreign investors have

three main points of

accessing China A

Shares: Stock Connect,

QFII and RQFII.


25

QFII requirements & other Arrangements

International fund management institutions, insurance companies,

securities companies and other asset management institutions must be

approved by the China Securities Regulatory Commission (CSRC) and

granted investment quotas by the State Administration of Foreign

exchange (SAFE).

For Chinese investors, a reciprocal scheme to QFII, the Qualified

Domestic Institutional Investor scheme (QDII), was introduced in 2006 that

allows Chinese financial institutions to invest overseas in foreign fixed

income and equities. The eligible foreign markets include those that have

signed a Memorandum of Understanding (MOU) with the CSRC.

Wholly foreign-owned enterprises (WFOE) are also available for overseas

companies to access the mainland market. They are 100% foreign-owned

firms that can manufacture and market their own products for sale to

mainland investors. This structure allows overseas asset management

companies to operate under their own name and benefit from the same

rules as local private funds.23

Renminbi Qualified Foreign Institutional Investors (RQFII)

Introduced in 2011, RQFII is a local currency version of QFII which permits

investment in the same range of investment products and is subject to many of

the same restrictions. Initially the RQFII program was limited to only Chinese

financial institutions with subsidiaries in Hong Kong but has been expanded to

other Hong Kong financial institutions and institutions in other countries including

Australia, Canada, United States, Hungary, France, Germany, Switzerland,

Luxembourg, Ireland, United Kingdom, South Korea, Singapore, Taiwan,

Malaysia, Thailand, UAE and Chile.24

Like QFII, approvals from both CSRC and

SAFE are also required.

23

Source: http://www.wfoe.org/ 24

CSRC

http://www.wfoe.org/


26

Prior to the Stock Connect scheme, if investors did not have QFII/RQFII quota,

their only alternative access point to the mainland market was via overseas

Chinese listings. However, only 24% of China A Share companies (by market

cap) can be accessed by other China share classes. Although large cap China A

Shares have the highest representation, they make up only 33.7% (Chart 21).

Chart 21: Overseas China listings only provide a small exposure to the

mainland equity market

Source: FTSE Russell as at August 31, 2018.

Connect Schemes

Connect schemes are the newest and most flexible entry points to China's

domestic equity (Stock Connect) and bond (Bond Connect) markets for foreign

investors. Connect provides a mutual market-access program that allows

international and mainland Chinese investors to trade securities in each other's

markets using eligible local trading and clearing facilities. Connect helps pave the

way for Chinese securities to be included in global benchmarks.

Stock Connect

Stock Connect has been growing rapidly. First launched in 2014 (Shanghai-Hong

Kong Stock Connect), Stock Connect is a collaboration between the Hong Kong,

Shanghai and Shenzhen stock exchanges and allows Hong Kong and foreign

investors to access eligible listed securities using broker accounts in Hong Kong.

The link was extended in 2016 to the Shenzhen and Hong Kong stock

exchanges (Shenzhen-Hong Kong Stock Connect). Each link has a daily quota of

RMB 52 billion (USD 8bn) − increased from RMB 13 billion (USD 2bn) since May

1, 2018.

33.7

5.7 2.0

24.0

0

5

10

15

20

25

30

35

40

FTSE China A LargeCap Index

FTSE China A MidCap Index

FTSE China A SmallCap Index

FTSE China A AllCap Index

% of China A Shares (by market cap) Accessed by Other China Share Classes

Stock Connect has

been growing rapidly.


27

Under Shanghai Connect, Hong Kong investors can trade constituent stocks of

the SSE180, SSE 380 indexes and all dual-listed A Shares that have an

equivalent H Share on the Hong Kong stock exchange.25

For Shenzhen Connect, Hong Kong and overseas institutional investors can

trade the Shenzhen Component index - the main index whose constituent stocks

are available for investment through the scheme - and the Shenzhen Mid- and

Small-Cap Innovation index, with a minimum market cap of RMB 6 billion. This

represents some 900-listed securities. Similar to the Shanghai Connect, all dual-

listed A Shares that have an equivalent H Share on the Hong Kong stock

exchange are also eligible.

Elsewhere, separate preparations are being made to create a new link between

Shanghai and the London Stock exchanges (Shanghai-London Stock Connect).

Today, the Stock Connect program covers some 2000 eligible Chinese

equities.26

Restrictions of access schemes

While the development of access routes is constantly evolving, there are still

some restrictions which do not provide the same mechanisms and coverage that

international investors are accustomed to when accessing capital in other

developing markets.

The recent removal of restrictions on the outflow of capital is a positive

development. However, QFII and RQFII accounts are not available to all

investors. For example an investor has to be of a certain size, assets

under management, experience and have its principal place of business

in certain jurisdictions to receive a license and quota.

Stock Connect, QFII and RQFII access routes operate on a pre-funded

basis, with securities settling on T+0 and cash settling on T+1. For Stock

Connect, Delivery versus Payment (DvP) is not available or available at

an additional cost via a local broker/custodian.

There are concerns over the availability of CNH/CNY around index

balances. The PBOC recently permitted 20 foreign exchange banks in

Hong Kong which have a China Foreign Exchange Trade System

(CFETS) license to offer onshore RMB (CNY) for Stock Connect

settlement which should alleviate this concern.

Security suspensions: a barrier to entry

Despite continued positive market developments, the high incidence of security

suspensions, which far exceeds those in other markets, affect the ability of index

trackers to replicate benchmark changes. At the height of the stock market

decline on July 9, 2015, nearly half of China's 1424-plus listed companies, as

measured by the FTSE China A All Cap Index, halted trading.

25

HKEX at https://www.hkex.com.hk/Mutual-Market/Stock-Connect/Eligible-Stocks/View-All-Eligible-Securities?sc_lang=en 26

HKEX at http://www.hkex.com.hk/Mutual-Market/Stock-Connect?sc_lang=en

There has been a high

incidence of security

suspensions, but more

recently levels have

decreased to about 4%.

Stock Connect covers

some 2000 eligible

Chinese equities.

https://www.hkex.com.hk/Mutual-Market/Stock-Connect/Eligible-Stocks/View-All-Eligible-Securities?sc_lang=en


28

On average between the beginning of 2015 to August 201827

approximately 8%

of China A Share securities in the FTSE China A All Cap Index have been

suspended on a daily basis. More recently, levels have decreased to about 4%.

Chart 20: The rising number of suspensions has affected the Chinese

market

Source: FTSE Russell, Wind, data as at August 31, 2018. Past performance is no guarantee of future results. Returns shown prior to index launch reflect hypothetical, historical performance. Please see the end for important disclosures.

For a detailed summary of the different equity access schemes consult

Table 1 in the Appendix (page 48).

27

FTSE Russell, data from January 5, 2015 to August 31, 2018.

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

0

100

200

300

400

500

600

700

800

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Pric

e R

etru

n In

dex (C

NY

) Nu

mb

er

of

Su

sp

en

sio

ns

Number of Suspensions vs FTSE China A All Cap (CNY)

Number of Suspensions (LHS) FTSE China A All Cap Index (RHS)


29

5. Rising star – China's fixed-income market

China's bond market has come a long way since the first bond was issued in

1980. It ranks today as the third largest bond market in the world behind the

United States and Japan.

Chart 22: Chinese bond market has grown significantly in the last 10 years

Source: WIND, August 31, 2018.

China's onshore bond market is dominated by sovereign and regional

government bonds with a growing credit sector. Investors view policy bank bonds

(non-commercial, 100 percent state-owned banks that lend in support of

government priorities) having similar risk as sovereign bonds. Municipal bonds

have been growing rapidly since 2015.

Chart 23: Segmentation of the Chinese onshore bond market (% weight)

Source: WIND, August 31, 2018.

Size RMB Trillion, 81.21

0

10

20

30

40

50

60

70

80

90

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Siz

e i

n R

MB

Tri

llio

n

Size of Chinese Bond Market Since 2009

0 5 10 15 20 25

Other

Commercial papers

Asset-backed securities (ABS)

Negotiable certificate of deposit (NCD)

Policy bank bonds

China government bonds

Regional government bonds (Municipal bonds)

Corporate bonds

China’s bond market

ranks third largest in the

world.

China’s domestic bond

market is dominated by

sovereign and regional

government bonds.


30

The majority of outstanding issues, many of which have implied government

support, are AA-rated by local Chinese rating agencies (Chart 24).

Although international foreign ratings agencies are now allowed to operate in

China to rate domestic Chinese issuers, at the time of writing none had been

granted a license. Prior to the change in the rules, global rating agencies could

only hold minority stakes in joint-venture operations and not issue ratings on local

bonds.

Chart 24: Most Chinese bonds, which defaulted, were rated AA at issuance

Source: Wind, August 31, 2018.

Chinese onshore bonds are mostly traded through the interbank bond market

(Chart 25), which includes a wide range of financial institutions. In addition to

their on-balance sheet holdings, commercial banks, which dominate the market

in terms of ownership, control many bonds through their off-balance sheet wealth

management products (see Shadow Banking box on page 13) that they sell to

customers as a higher yielding alternative to traditional saving deposits.28

28

Financial Times, July 3, 2017 – China’s interbank bond market in five charts

0%

5%

10%

15%

20%

25%

30%

35%

40%

AA

A

AA

+

AA

AA

- A A-

A-1

BB

B

No

n-R

ate

d

Rating at Issuance (Outstanding Amount %)

Chinese onshore bonds

are mostly traded

through the interbank

bond market.

International foreign

ratings agencies are

now allowed to operate

in China to rate

domestic Chinese

issuers, but none has

been granted a license.


31

Chart 25: The majority of local bonds trade on the China Interbank Bond

Market

Source: CCDC, SCH, CSDC and HSBC Securities Services.

As the authorities continue to restrict off-balance sheet lending and push up

funding costs, corporate bond defaults have risen six-fold since the end of 2015.

2016 saw the largest number of defaults when 78 bonds defaulted, which

represented RMB 39.3 billion in principal amount. In the first eight months in

2018, the issue sizes were significantly larger with 60 bond defaults representing

RMB 57.38 billion in principal amount (Chart 26).

Chart 26: The number of corporate bond defaults peaked in 2016, but is

rising again

Source: Wind, August 31, 2018.

85.6

13.2

1.0 0.2

Share of Bond Markets (%)

Interbank

Exchange

OTC

Others

0

10

20

30

40

50

60

0

10

20

30

40

50

60

70

80

90

2014 2015 2016 2017 2018 tillAugust 31

To

tal d

efa

ults

(RM

B b

illion

)

Nu

mb

er

of

Defa

ult

s

Number of defaults (LHS) Total Amount in default (RHS)

The number of

corporate bond defaults

peaked in 2016, but is

rising again.


32

The increased incidence of corporate defaults reflects the government's efforts to

contain leverage and reduce complexity in the financial system, particularly

through a clampdown on shadow-financing activities. Corporates over stretched

their balance sheets during the previous credit boom to fund aggressive business

expansion, and those which had uncompetitive or structurally ailing business

models have struggled to refinance their maturing debt.

Nearly 20% of bond defaults are by state-owned enterprises as regulators moved

away from the old model of implicit guarantees for most debt securities to allow

defaults to take place.

Chart 27: Corporate issuers are making up the majority of defaulting bonds

Source: Wind as at August 31, 2014-2018.

0%

10%

20%

30%

40%

50%

60%

70%

Chinese andforeign joint

venture

Foreignenterprise

local state-owned

enterprise

Privateenterprise

State-ownedenterprise

Whollyforeign-owned

enterprise

Others

Percentage of Default Bonds

Nearly 20% of bond

defaults are by state-

owned enterprises.


33

Much of the outstanding debt issuance has been tilted towards short maturities,

with the majority of issues due to mature in less than four years (Chart 28).

Chart 28: China's average bond life is less than five years

Source: FTSE Russell and Wind, August 31, 2018; WAL= Weighted Average Life based on FTSE Chinese (Onshore CNY) Broad Bond Index, Regional Government and FTSE Chinese (Onshore CNY) Broad Bond Index, Corporate.

New issuance has fallen sharply as the central bank has squeezed liquidity and

China's banking regulator introduced new regulations to discourage leveraged

investment in the bond market.

Chart 29: Bond issuance has declined sharply since 2016

Source: FTSE Russell and Wind, August 31, 2018.

2

3

4

5

6

Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17 Jan-18 Jul-18

We

igh

ted

Ave

rage

Lif

e (

Ye

ars)

Municipal WAL Corporate WAL

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

New Issuance Amount (RMB Billion)

Municipal bonds (local government) Corporate bonds

August 31, 2018

New issuance has fallen

sharply as China's

banking regulator

introduced new

regulations to

discourage leveraged

investment in the bond

market.


34

6. Foreign investor access to the Chinese onshore bond market

Foreign investor access to the Chinese domestic debt market has been less

restrictive than equities. The market has grown to RMB 81 trillion (USD12 trillion).

In 2002, the China Securities Regulatory Commission and the PBOC initiated the

QFII scheme to allow foreign investors to enter China's capital markets directly.

Chart 30: Evolution of the opening up of the Chinese bond market

Source: FTSE Russell

Like the equity access, international investors can access the Chinese

government bond market via a number of routes: QFII, RQFII, CIBM* Direct and

Bond Connect schemes (refer to Table 2 on page 35).

International investors are also given direct access to primary issuances in the

CIBM. Not all derivatives are yet available to foreign investors, although more

derivatives are available on CIBM. For Bond Connect, only cash bonds are

available currently.

Bond Connect

Launched in July 2017, Bond Connect29

provides the Northbound access to the

China Interbank Bond Market. This mutual market-access scheme allows

investors from mainland China and overseas to trade in each other's bond

29

Bond Connect admission of eligible foreign investors http://www.chinabondconnect.com/documents/AccessRules-20170630.pdf

*CIBM= Chinese Interbank Bond Market

2010 2011 2012 2013 2014 2015 2016 2017 2018

Aug 2010 PBOC launched a pilot scheme allowing (i) foreign banks or monetary authorities, (ii) RMB settlement banks in HK and Macau and (iii) cross-border RMB settlement participating banks in HK and Macau to trade and settle bonds in the CIBM.

2013 RQFIIs across jurisdictions were also allowed to invest in the CIBM, subject to PBOC approval.

Apr 2015 First onshore SOE defaults.

July 2015 PBOC announced that central banks, monetary authorities, international financial organizations could invest in the CIBM without approval requirements and quota limits.

Feb 2017 Hedging tools including FX forwards, FX swaps and currency swaps approved by policy makers.

July 2017 Bond Connect is operational, allowing international investors to access the onshore bond market via HK accounts.

Dec 2011 HK-based subsidiaries of

Chinese fund management and securities companies, which had been granted RQFII status during the 1

st phase of the scheme

were allowed to apply for approval and quota to invest in the CIBM via a bond settlement agent.

Feb 2016 Quota-free access to CIBM market.

May 2016 Restrictions on repatriation of currency and holdings periods are eliminated.

Oct 2016 IMF includes CNY in the Special Drawing Right basket, the 1

st addition for 15 years and

making it the 3rd

largest in the basket of currencies held as reserves for IMF members.

Feb 2018 Phased, inclusion of

Onshore Treasury bonds into the FTSE EMGBI, AGBI and APGBI.

Jun 2018 SAFE removed the restrictions on the repatriation for QFII/RQFII investors; also allows currency forward to be used for hedging purpose.

http://www.chinabondconnect.com/documents/AccessRules-20170630.pdf


35

markets through connection between the related mainland and Hong Kong

Financial Infrastructure Institutions (the Hong Kong Exchanges and Clearing

Limited (HKEX) and the Central Moneymarkets Unit (CMU).

Prior to Bond Connect, foreign investors could access China’s onshore bond

market through the CIBM direct channel without quota through a local bond

settlement agent. Today, foreign investors can buy Chinese debt directly through

Bond Connect.

Table 2: Comparison of the various bond access schemes available to

foreign institutional investors

Shares Class QFII RQFII.

RMB Participating Bank CIBM Bond Connect

Scheme Launch Year

2002 2011 Opened to foreign investors in March 2016 (but available to central banks, SWF and international organizations since July 2015)

2017

Eligible Investments

Cash bonds Cash bonds Cash bonds; RMB repo

Cash bonds, RMB IRS and bond forwards for hedging

Cash bonds

Repatriation No monthly repatriation limit since June 2018

No monthly repatriation limit since June 2018

RMB only Roughly maintain foreign currency and RMB ratio

No repatriation restrictions

Quota Investment quota for each QFII

Investment quota for each RQFII

Investment quota for each RMB participating bank

No investment limit; no intended amount

No investment limit

Source: FTSE Russell and Linklaters 2017.

However, there remains some restrictions for foreign investors

Monetary policy communication appears to be less clear compared with

that of major central banks, in major bond markets (UK, US, Japan and

Eurozone).

Perception of exchange rate risk could remain high if China's 'managed

floating' regime continues to see frequent parameter changes that are

not clearly articulated.

RMB is the highest ranked emerging market currency by turnover, but its

share of global turnover remains relatively modest (~4%).

Sovereign credit risk is difficult to assess given the potential large

liabilities not reflected by the level of government debt and fiscal deficit.

Bond Connect provides

the Northbound access

to the China Interbank

Bond Market.

There remains some

restrictions for foreign

investors to access

China’s onshore bonds.


36

The level of foreign ownership in the overall domestic market is markedly

low, at around 2%, despite a 41% YOY growth in foreign inflows in

2017.30

The index impact of its inclusion will be significant, owing to the

substantial size of the Chinese debt market.

The inclusion of Onshore Treasuries would represent 5.8% of the FTSE

World Government Bond Index.

While it is generally improving, liquidity remains a concern particularly for

off-the-run bonds, Policy Bank bonds are more liquid than treasuries.

CDs are the most actively traded instrument on Bond Connect.

There is no coverage of onshore CNY credit bonds by international rating

agencies which are in the process of getting a license.

However, since August 30, 2018, foreign bond investors have been exempted

from corporate income tax and VAT for a tentative period of three years for non-

government bonds (regional and government bonds are exempted).

Renminbi: Gaining importance globally?

China's opening of its financial and capital markets is helping the renminbi

become a major global currency which, based on the Bank of International

Settlements data,31

ranks as the 8th most traded currency worldwide (Table 2).

The introduction of a hybrid net settlement clearing system, the Cross-Border

Interbank Payment System (CIPS) for on and offshore businesses trading in

yuan, has created an express channel for the internationalization of the currency.

CIPS is modelled on USD CHIPS and uses SWIFT messaging as well as SWIFT

standards.32

The use of CIPS has greatly improved the efficiency of cross-border clearing and

marked major progress in establishing a modern payment system that complies

with international standards. As a result, the Chinese yuan has become

increasingly used as a settlement currency within Asia Pacific since the

establishment of Hong Kong and Shanghai as offshore RMB clearing centers.

30

Wind, September 2018 31

BIS, April 2016, https://www.bis.org/statistics/d11_1.pdf 32

Source: TMI, January 2016 https://www.treasury-management.com/article/1/355/2929/cips-chinas-hybrid-net-settlement-clearing-system.html

Since August 30, 2018,

foreign bond investors

are exempted from

corporate income tax.

China's opening of its

financial and capital

markets is helping the

renminbi become a

major global currency

which ranks as the 8th

most traded currency

worldwide.

https://www.bis.org/statistics/d11_1.pdf

https://www.treasury-management.com/article/1/355/2929/cips-chinas-hybrid-net-settlement-clearing-system.html

https://www.treasury-management.com/article/1/355/2929/cips-chinas-hybrid-net-settlement-clearing-system.html


37

The Cross-Border Interbank Payment System (CIPS)

CIPS provides controlled cross-border access to the onshore CNY

clearing system (China National Automated Payment System version 2)

for use in offshore and cross-border CNY payments, so that offshore CNY

settlement can access onshore liquidity directly. However, CIPS does not

facilitate funds transfer, rather it sends payment orders which must be

settled by correspondent accounts that the institutions have with each

other.

Table 2: The yuan ranks in the top ten of the most traded currencies

Year 2001 2004 2007 2010 2013 2016

FX Share Rank Share Rank Share Rank Share Rank Share Rank Share Rank

USD 89.9 1 88 1 85.6 1 84.9 1 87 1 87.6 1

EUR 37.9 2 37.4 2 37 2 39 2 33.4 2 31.4 2

JPY 23.5 3 20.8 3 17.2 3 19 3 23 3 21.6 3

GBP 13 4 16.5 4 14.9 4 12.9 4 11.8 4 12.8 4

AUD 4.3 7 6 6 6.6 6 7.6 5 8.6 5 6.9 5

CAD 4.5 6 4.2 7 4.3 7 5.3 7 4.6 7 5.1 6

CHF 6 5 6 5 6.8 5 6.3 6 5.2 6 4.8 7

CNY 0.0 35 0.1 29 0.5 20 0.9 17 2.2 9 4.0 8

SEK 2.5 8 2.2 8 2.7 9 2.2 9 1.8 11 2.2 9

NZD 0.6 16 1.1 13 1.9 11 1.6 10 2 10 2.1 10

Source: BIS, April 2016.


38

7. China is opening its equity market to international investors

China's deepening integration into global financial markets provide opportunities

to international investors as they look to diversify their exposure to a market

where the majority of investors have historically had no access. However there

remain outstanding questions on the appropriate allocation and trading schemes

to accomplish this. For example, when do investors need to review their current

China portfolios in the light of the opening of the mainland Chinese equity

market? Do investors have a diversified representation of the Chinese economy?

Do their existing allocations support changes in accessibility of the China share

classes and its future economic shift?

As China continues to open its financial markets to international investors, it will

become increasingly important for investors to understand the profile of each to

make informed decisions around their China equity allocations. For example,

China's listed equity markets will come to dwarf the rest of the emerging markets

(Chart 31). In the FTSE Emerging Markets All Cap China A Inclusion (No Quota)

Index, exposure to China A Shares makes up nearly half of the total China

weight, while in contrast China A Shares are not currently included in the FTSE

China Index.

Chart 31: China's A Shares represent a large weight within emerging

market indexes.

Source: FTSE Russell, data as at August 31, 2018. Hypothetical index created for research and illustrative purposes only. Please see the end for important legal disclosures.

Investors will also need to understand that over half of the Chinese stock

universe is represented by China A Shares to which they have had limited

access historically.

32.2 30.9 25.2 22.8

4.0 21.7 29.0

0

10

20

30

40

50

60

China(excluding China A

Shares)

China(including China A

Shares at theiraggregate quota)

China(including China A

Shares at theirforeign ownershipadjusted weight)

China(including China AShares at their free

float adjusted weight)

Weig

ht

in in

dex (

%)

China's expansion in various FTSE Emerging markets All Cap Indexes

B Share, H Share, N Share, Red Chip, P Chip, S Chip

China A Share

Hypothetical index with neither FOL or

R/QFII quota restrictions for A

Shares

FTSE Emerging Markets All Cap

China A Inclusion

(No Quota) Index

China's listed markets

will come to dwarf the

rest of the emerging

markets.

FTSE Emerging Markets All Cap

China A Inclusion Index FTSE Emerging All

Cap Index

It will become

increasingly important

for foreign investors to

understand the onshore

market profile to make

informed decisions

around their China

equity allocations.


39

Chart 32: Investor access to overseas listings (excludes China A Shares)

Source: FTSE Russell, data as at August 31, 2018, based on FTSE China International All Cap Index.

The FTSE China A All Cap Index comprises 1,919 China A Share constituents,

representing 56% of the total Chinese equity market universe.

Chart 33: China A Shares are significantly larger than the other China share

class listings

Source: FTSE Russell, data as at August 31, 2018, based on FTSE China International All Cap Index; the weight is calculated assuming the A Shares are included at their free float adjusted market capitalization (i.e. without FOL).

A growing but small number of investors have already 'dipped their toes' into the

domestic Chinese market via strategic allocation in QFII/RQFII that has grown

over time as they become more accustomed to the mainland market.

Others have used tactical allocations via futures and funds tracking key index

benchmarks depending on whether they want exposure to China A Shares or

related equities that are listed in Hong Kong and overseas markets.

1.0

33.0

23.9

29.8

12.1 0.2

Weight in China Universe (%)

B Shares

H Shares

N Shares

P Chips

Red Chips

S Chips

53

143

36

174

63 7

Number of Constituents in China Universe

B Shares

H Shares

N Shares

P Chips

Red Chips

S Chips

0.4

14.5

10.5

13.1

5.3

0.1

56.0

Weight in China Universe (%)

B Shares

H Shares

N Shares

P Chips

Red Chips

S Chips

A Shares

53 143 36

174

63

7

1,919

Number of Constituents in China Universe

B Shares

H Shares

N Shares

P Chips

Red Chips

S Chips

A Shares

China A Shares are

significantly larger than

the other China share

class listings.


40

8. FTSE Russell's approach to managing China's transition into global benchmarks

FTSE Russell continues to support investment choices through years of

experience in the mainland China market. As the first international provider of

mainland Chinese benchmarks and an index product range that demonstrates

the breadth and depth of China's equity and bond markets, FTSE Russell leads

the way in providing solutions to its clients' needs.

FTSE Russell acknowledges the efforts of the Chinese authorities to increase the

accessibility of the China A Share market for international investors. Since March

2018, FTSE Russell has evaluated the China A market against the three access

routes available to foreign investors:

Stock Connect

Qualified Foreign Institutional Investor (QFII)

Renminbi Qualified Foreign Institutional Investor (RQFII).

As a result of recent enhancements to the Northbound Stock Connect program,

including but not limited to a four-fold increase in the Daily Quota limit and the

use of the Special Segregated Accounts (SPSA), which allows the facilitation of

effective DvP via the Northbound Stock Connect program, China A Shares

available via the Northbound Stock Connect route will be assigned as

Secondary Emerging.

The following provides a high level summary of the first phase of FTSE Russell’s

China A share implementation plan:

Stock Selection: constituents of the FTSE China A Stock Connect All

Cap Index

Size Segments: large, mid and small securities

Portion of China A Shares being added: 25% of each security's

investability weight

Implementation Commencing: June 2019 (nine months’ notification)

Implementation Schedule: Three tranches - June 2019, September

2019 and March 2020 (phase 1)

Size Tranche: 20% in June 2019, 40% in September 2019* and 40% in

March 2020*

Regional Review: China to be reviewed separately from Asia Pacific ex

Japan

* Please note that the implementation of Tranche 2 in September 2019 and Tranche 3 in March 2020 will be contingent upon the successful implementation of Tranche 1 in June 2019.

China A Shares

available via the

Northbound Stock

Connect route will be

assigned as Secondary

Emerging.


41

The future: the inclusion of China A Shares in FTSE Russell’s global equity indexes

How the addition of China’s A Shares in the FTSE Russell’s indexes will look like

in the future will depend on the continued development of this market. The end

goal is for all China A Shares to be included, not just those that are available via

the Northbound Stock Connect program. Constituents will initially be weighted by

foreign ownership limits (and not quota), and finally, where foreign ownership

restrictions have been relaxed, companies will be weighted by their free floats.

Prior to the conclusion of phase 1 in March 2020, FTSE Russell will consider the

inclusion of future tranches and any market developments that have taken place

in the meantime. Such a future proposal would consider:

Whether the size of the next phase should be based on a) any increase

to the quota sizes since the commencement of phase 1, or b) whether

phase 1 should be repeated (i.e., taking the total inclusion factor to 50%);

Whether stocks outside of Stock Connect should be included (this will

depend on enhancements to the QFII and RQFII access routes);

The availability of DvP via the QFII and RQFII access routes;

The timing of future tranches.

Chart 34. The growth of China A Shares in the FTSE Emerging Index

The sizes of tranches

Source: FTSE Russell – data as at 31 August 2018. This graph contains forward-

looking representations based upon a number of

assumptions concerning future conditions that ultimately may prove to be inaccurate.

33.79 33.01 32.02 31.09 26.46 24.26

1.17 3.40 5.51 19.57 26.24

0

10

20

30

40

50

60

70

Weig

ht

in I

nd

ex (

%) 50.51

46.03

36.59

China ex A Shares (includes B, H, N Shares & P, Red,S Chips)

China A Shares (Stock Connect)

China A Shares

FOL adjusted

China A Shares

free float adjusted

Jun

2019

Aug 2018

35.42 34.17 0

Sep 2019

Mar 2020

the Future

FTSE Russell will

consider the inclusion of

future tranches following

the conclusion of the

phase 1 inclusion.


42

Chart 35. The expected growth of China A Shares in the FTSE All-World

Index

Source: FTSE Russell – data as at 31 August 2018. These charts contain forward-looking representations based upon a number of assumptions concerning future conditions that ultimately may prove to be inaccurate. Please see the end for important legal disclosures.

Full details of the implementation are available on the FTSE Russell website at:

https://www.ftse.com/products/indices/country-classification

FTSE Russell has a rigorous inclusion methodology

While an important first step, it takes more than just opening up a market to

attract foreign capital. Investors must be assured that important criteria for

market efficiency and quality (such as asset security, ease of access and trading)

are met. Ensuring that those investor conditions are achieved lies at the

foundation of the FTSE Russell country classification evaluation process.

China's classification process is a result of constructive engagement with

Chinese regulators, stock market officials and international investors/custodians.

To attain the Secondary Emerging classification, a market must satisfy nine of

the 21 key market quality and regulatory criteria, referred to as the FTSE Quality

of Markets Matrix.

Consistent with the Principles for Financial Benchmarks published in 2013 by

International Organization of Securities Commissions, which promotes regulatory

standards for the world's securities and futures markets, the operation of the

country classification process is overseen by FTSE Russell's strong internal

governance structure, supported by independent advisory committees consisting

of senior market practitioners with extensive global market knowledge and

experience.

3.22 3.22 3.21 3.21 3.15 3.12

0.11 0.34 0.57

2.33 3.37

0

1

2

3

4

5

6

7

8

9

Weig

ht

in I

nd

ex (

%)

China ex A Shares (includes B, H, N Shares & P, Red, S Chips)

China A Shares (Stock Connect)

China A Shares

FOL adjusted

China A Shares

free float adjusted

Aug

2018

Jun 2019

Sep 2019

Mar 2020

the Future

6.48

5.48

3.77 3.56 3.34

0

China's classification

process is a result of

constructive

engagement with

Chinese regulators,

stock market officials

and international

investors/custodians.

https://www.ftse.com/products/indices/country-classification


43

FTSE Russell classifies countries according to objective criteria and engages

with stock exchanges, regulators and central banks in those countries where

markets are being considered for potential reclassification. The transparency of

the process provides portfolio managers and asset allocators with a clear view of

expected future index evolution.

To give investors time to plan for potential classification changes, FTSE Russell

operates a Watch List of those countries with scores on the Quality of Markets

matrix that have been judged to have met (or are becoming close to meeting) the

technical criteria required for reclassification.

China's inclusion into the FTSE Global Equity Index Series (GEIS)

FTSE Global China A Inclusion Indexes are available for market participants,

with a choice of how to include China A-shares in global benchmarks. The series

also includes FTSE China A Indexes and China A Stock Connect Indexes.

Please refer to the following Link for further information on FTSE Russell

Country Classification: .https://www.ftse.com/products/downloads/FTSE-

Country-Classification-Update_latest.pdf

The transparency of the

process provides

portfolio managers and

asset allocators with a

clear view of expected

future index evolution.

https://www.ftse.com/products/downloads/FTSE-Country-Classification-Update_latest.pdf

https://www.ftse.com/products/downloads/FTSE-Country-Classification-Update_latest.pdf


44

Table 3: China A Shares latest inclusion assessment in global equity

benchmarks

FTSE Quality of Markets

Secondary Emerging

China A Share via Stock Connect *

China A Share via QFII**

China A Share via RQFII**

Formal stock market regulatory authorities actively monitor market

Yes Pass Pass Pass

No objection to or significant restrictions or penalties applied to the investment of capital or the repatriation of capital and income

Yes Pass Restricted Restricted

Settlement – rare incidence of failed trades

Yes Pass Pass Pass

Custody – sufficient competition to ensure high quality custodian services

Yes Pass Pass Pass

Clearing and settlement – T+2 / T+3

Yes T+0 / T+1*** T+0 T+0

Brokerage – sufficient competition to ensure high quality broker services

Yes Pass Restricted Restricted

Liquidity – sufficient broad market liquidity to support sizeable global investment

Yes Pass Pass Pass

Transaction costs – implicit and explicit costs to be reasonable and competitive

Yes

Pass Pass Pass

Transparency – market depth information / visibility and timely trade reporting process

Yes

Pass Pass Pass

Source: FTSE Russell as at September 26, 2018.

* China A Share via Northbound Stock Connect to be reclassified as Secondary Emerging,

commencing June 2019

** Other China A Share access routes - currently Unclassified

*** Indicates a rating change from March 2018 decision


45

The FTSE Russell Country Classification Process

FTSE Russell classifies stock markets as either Developed, Advanced

Emerging, Secondary Emerging or Frontier following a rigorous, systematic

and research-based process.

Markets are assessed against a set of 21 criteria referred to as the FTSE

Quality of Markets Matrix, which is used to evaluate the suitability of inclusion

based on each market’s scale, regulatory environment, liquidity, stability and

ease of non-domestic investor access.

The FTSE Russell process was developed in conjunction with and is

supported by an independent Country Classification Advisory Committee,

which consists of senior market practitioners with a wide range of technical

expertise in trading, portfolio management and custody services. With support

from its independent advisors, FTSE Russell also actively engages with local

authorities on technical issues or concerns that may require to meet

international standards.

FTSE Russell maintains a “Watch List” for markets potentially approaching

reclassification and, as a policy of engagement, to help them understand the

steps needed to meet international standards.

On this basis, the Country Classification Advisory Committee makes

recommendations to FTSE Russell’s Product Governance Board, which

renders the final decision on classifications. The Annual Country

Classification announcement is published each September and an Interim

Update is published in March.

http://www.ftserussell.com/sites/default/files/indexing-the-world_0.pdf


46

FTSE Russell’s approach to China’s onshore bonds classification

FTSE Russell provides a range of fixed income indexes designed to measure the

performance of onshore Chinese yuan-denominated fixed-rate government,

agency, and corporate debt issued in mainland China. These include the FTSE

Chinese (Onshore CNY) Broad Bond, the FTSE Chinese (Onshore CNY) Broad

Bond Index and the FTSE Chinese Government and Policy Bank Bond

(CNGPBI) Indexes.

FTSE Russell’s multi-currency benchmarks were also the first to include Onshore

Chinese government bonds in emerging market and regional government bond

indexes − following a 2016 client consultation, it was announced in March 2017

that China would be added to the flagship EM local currency FTSE EMGBI; as

well as the regional FTSE Asian Government Bond Index (AGBI). Inclusion was

effective from February 2018, with weight staggering over three months. While

FTSE Russell’s fixed income benchmarks offer broad tracking of China in

standalone, emerging markets and regional benchmarks, it is not currently a

member of our flagship multi-currency government investment grade FTSE

World Government Bond Index (WGBI).

In the fixed income benchmarking world, credit quality has tended to supersede

formal emerging market definitions, creating what are commonly referred to as

“crossover markets” within flagship investment grade, multi-currency benchmarks

for global portfolios. Benchmarks such as the FTSE World Government Bond

Index (WGBI) are comprised of high credit quality government bond markets that

are generally considered developed but have overlap with dedicated emerging

markets benchmarks such as the FTSE Emerging Markets Government Bond

Index (EMGBI). Examples of such crossover markets currently include South

Africa, Mexico and potentially China.

FTSE Russell has recently completed a market consultation on our proposal for a

robust and process-oriented fixed income country classification framework for

local currency government markets. It will calibrate a Market Accessibility Level

for a superset of local fixed-rate government bond markets with accessibility

measured across four dimensions: Market, Macroeconomic and Regulation;

Foreign Exchange and Fixed Income Derivatives; Technical and Market

Structure; and Global Settlement and Custody. These levels will be formally

incorporated into the inclusion criteria of flagship multi-currency FTSE Russell

government benchmarks and available for use in custom indexes.

As with the equity framework, a Watch list of countries on the cusp of

reclassification will be published and maintained with status updates provided

each March and September. Inclusion of a market on the Watch List signals

FTSE Russell’s intent to engage with governments, central banks and regulators

to address specific feedback from investors on the fulfilment of the criteria for the

proposed accessibility level. China government bonds will be added to this

Watch List and assessed against the stated criteria of the framework for possible

inclusion in the FTSE World Government Bond Index. The full FTSE Fixed

FTSE Russell has

recently completed a

market consultation on

our proposal for a

robust and process-

oriented fixed income

country classification

framework for local

currency government

markets.


47

Income Country Classification framework and a complete Watch List will be

published later this year.

Our goal as a multi-asset index provider is to offer index users and stakeholders

clarity and transparency into the country classifications that underpin our

benchmark construction for both fixed income and equity markets, while

acknowledging and preserving the clear and important nuances between the two

asset classes.

Conclusion

China has achieved an extraordinary economic transformation over the last fifty

years to become the world’s second largest economy. Political stability and long-

term reforms have urbanized its vast population and driven its expansionary

policies into manufacturing and export-orientated growth. Lifestyles are changing

with increasing demand for better healthcare and consumer services by a rapidly

growing middle class and a focus towards automation and robotics by a shrinking

working population. In the process of this gigantic undertaking, there has been

costs to the environment and financial stability. But these are being addressed

and redirected into new opportunities. China today is becoming a dominant

player in the green economy and reforming its financial system to provide a

robust corporate governance framework in which international investors can

operate.

Historically, international investors have had limited access to China’s vast

domestic market. Today there are a number of investment access routes as the

country opens its local market to international investors. As more overseas

investors enter China’s onshore markets, they will need to review their existing

investment strategy and determine whether they have sufficient representation of

the Chinese economy and their allocations are diversified across the different

China share classes.

FTSE Russell is delighted to announce the introduction of China A Shares into its

global equity benchmarks. As a result of recent enhancements to the Northbound

Stock Connect program, including but not limited to a four-fold increase in the

Daily Quota limit and the use of the Special Segregated Accounts (SPSA), which

allows the facilitation of DvP, China A Shares available via the Northbound Stock

Connect route will be classified as a Secondary Emerging market.

For fixed income, FTSE Russell has recently completed a market consultation on

our proposal for a robust and process-oriented fixed income country classification

framework for local currency government markets. China has been included on

the Watch List of markets for potential future promotion.

The full FTSE Fixed

Income Country

Classification framework

and a complete Watch

List will be published

later this year.


48

9. Appendix

Table 1: The table below compares the different equity access schemes

and summarizes important differences (June 2018).

QFII RQFII Northbound Stock Connect

Scheme Launch Year 2002 2011 2014

Eligible Entities Asset Management

- Having operated fund business for over 2 years

- Not less than US$500 million in securities asset under management in the last financial year

Insurance companies

- Established for over 2 years

- Not less than US$500 million in securities asset under management in the last financial year.

Securities companies

- Having operated securities business for over 5 years

- Not less than US$500 million in net assets and not less than US$5 billion in securities asset under management in the last financial year.

Commercial banks

- Having operated banking business for over 10 years

- Not less than US$300 million in tier one capital and not less than US$5 billion in securities asset under management in the last financial year.

Others (pension fund, charity fund, endowment fund, trust company, government investment institution)

- Established for over 2 years

- Not less than US$500 million in securities asset under management in the last financial year.

- Qualified financial institutions registered and having its principal place of business in the approved RQFII sites with asset management license issued by the competent local securities regulator, and have already conducted relevant asset management business.

-Total 19 RQFII sites: Australia, Canada, Chile, France, Germany, Hong Kong, SAR, Hungary, Ireland, South Korea, Luxembourg, Malaysia, Qatar, Singapore, Switzerland, Thailand, UAE, UK, United States, and Japan. Note: QFII license holder is allowed to apply for RQFII as well.

Enable eligible Hong Kong investors investing to Shanghai Stock Exchange (SSE) & Shenzhen Stock Exchange (SZSE) - All Hong Kong and overseas institutional investors

- All Hong Kong and overseas individual investors Note: Shares listed on the ChiNextBoard of the SZSE will be available only to institutional professional investors


49


Investment Scope Shares, bonds and warrants listed and transferred on the stock exchange:

- Fixed income products traded on China Interbank Bond Market.* - Securities investment funds Index futures. - Small and Medium-sized Enterprise (SMEs) Private Placement Bonds. - Other financial instruments as approved by CSRC. - Subscription to IPO, additional issuance, rights issues, and convertible bond issuance. - FX derivatives (for hedging purposes).

*QFIIs and RQFIIs are allowed to trade cash bond, bond IPO and Negotiable Certificate of Deposit(per PBOC & CSRC’s verbal guidance). But trade in repo, margin trading and securities lending are still not allowed at the moment.

Same as QFII Currently limited to: SH-HK Northbound SC:

- All the constituent stocks of the SSE 180 Index and the SSE 380 Index.

- The SSE-listed shares which are dual-listed in Stock Exchange of Hong Kong (SEHK) (A+H Shares)

- Excluding: B Shares and shares under “risk alert”. SZ-HK Northbound SC

- All the constituent stocks of the SZSE Component Index and SZSE Small/Mid Cap Innovation Index with market capitalization of >RMB 6bn

- The SZSE-listed shares which are dual-listed in SEHK (A+H shares)

- Excluding: B Shares and shares under “risk alert”

Scheme Currency USD and other foreign currencies (converted to RMB onshore before investment commences).

RMB RMB

Quota Management Unique allowable investment allocation to each financial institution; funding is converted in RMB and registered with SAFE.

- QFIIs may obtain a Basic Quota up to a certain percentage of their asset size through filing with SAFE.

- When applying for the investment quota which exceeds the Basic Quota, QFII shall obtain SAFE’s approval.

When applying for additional quota for existing QFIIs:

- approved quota + additional quota < Basic Quota: filing with SAFE.

- approved quota + additional quota > Basic Quota: shall obtain SAFE’s approval.

Allocated to offshore regions

- RQFIIs may obtain a Basic Quota up to a certain percentage of their asset size through filing with SAFE

- When applying for the investment quota which exceeds the Basic Quota, RQFII shall obtain SAFE’s approval.

- When applying for additional quota for existing RQFIIs:

- approved quota + additional quota < Basic Quota: filing with SAFE

- approved quota + additional quota > Basic Quota: shall obtain SAFE’s approval

- A Basic Quota will be granted according to below benchmark:

- For RQFII or its group

Daily quota of the Northbound Stock Connect: RMB 52 billion.

Note: The quota is on a ‘first come first served’ basis.

SEHK Subsidiary shall continuously monitor the daily quota usage of Northbound Trading:

- Daily remaining quota=daily quota allowance – placed purchase orders + executed sale orders + cancelled/rejected purchase orders + difference between order price and execution price.

- Once the daily quota limit is triggered during continuous auction period, SEHK Subsidiary shall stop receiving


50


- A Basic Quota will be granted according to below benchmark:

- For QFII or its group company's asset (or assets under management) being mostly outside of mainland China: Basic Quota = USD100 million + 0.2%* average asset size or securities assets under management in the past three years

- approved RQFII Quota (USD equivalent) ;

- For QFII or its group company's asset (or assets under management) being mostly within mainland China: Basic Quota = RMB 5 billion + 80% * asset size or securities assets under management in the past one year

- approved RQFII quota (USD equivalent);

- Sovereign funds, central banks, and monetary authorities may obtain corresponding investment quota based on the investment needs in domestic capital market, and not be restricted by a certain percentage of their asset size

- Not exceeding USD 5 billion (including foreign central banks, monetary authorities and sovereign funds);

- Not less than USD 20 million

- Where a QFII fails to effectively utilize the investment quota within 1 year since filing or approval of investment quota upon obtaining the investment quota, SAFE has the right to revoke part or all of its unused Investment Quota.

- Adopted Balance Management regime: the accumulative net remitted-in amount by QFIIs shall not exceed the investment quota filed with or approved by SAFE.

-Sell or transfer of quota is prohibited.

company's asset (or assets under management) being mostly outside of mainland China: Basic Quota = USD100 million + 0.2% * average asset size or securities assets under management in the past three years - approved QFII Quota (RMB equivalent) ;

- For RQFII or its group company's asset (or assets under management) being mostly within mainland China: Basic Quota = RMB 5 billion + 80% * asset size or securities assets under management in the past one year - approved QFII quota (RMB equivalent);

- Sovereign funds, central banks, and monetary authorities may obtain corresponding investment quota based on the investment needs in domestic capital market, and not be restricted by a certain percentage of their asset size

- Where a RQFII fails to effectively utilize the investment quota within 1 year since filing or approval of investment quota upon obtaining the investment quota, SAFE has the right to revoke part or all of its unused Investment Quota.

-Adopted Balance Management regime: the accumulative net remitted-in amount by RQFIIs shall not exceed the investment quota filed with or approved by SAFE.

- Sell or transfer of quota is prohibited.

purchase orders while sale orders can be accepted.


51


Other Regulations & Restrictions

No lock-up period. Needs to be prefunded. FX derivatives trading are permitted: To engage in the onshore FX derivative trading following ‘trading on actual needs’ principle for the purpose of hedging FX risk. Positions of FX derivatives not to exceed their onshore asset value (ex cash) as of the previous month-end. FX derivatives can be adjusted on a monthly basis, within 5 working days of the following month to ensure compliance with the ‘trading on actual needs’ principle.

No lock-up period. RQFIIs are exempted from business tax on gains derived from the trading of securities in China. However, they are required to pay 10% corporate income tax of dividends, bonuses and interest income gained in China.

Funds must return to origin; No lock-up period. Connect covers only about 50% of listed shares on the mainland.

Trading Mechanism - For stock exchange trading: each QFII can appoint 3 domestic securities companies at Shanghai and Shenzhen stock exchanges respectively for securities trading.

-For CIBM trading: QFIIs shall appoint an interbank bond market settlement agent with international clearing capacity for trading and settlement.

Same as QFII Follow the same trading rules as China A Share market

Trading currency in RMB.

For SH-HK SC: SEHK will establish a wholly-owned subsidiary in Shanghai to receive orders to trade in SSE securities from Exchange Participants and rout them onto SSE’s trading platform for execution on SSE.

For SZ-HK SC: SEHK has established another SEHK

Subsidiary in Qianhai Shenzhen, whose principal function is to receive

orders to trade in SZSE Securities from SEHK Participants and route them

onto SZSE’s trading platform for matching and execution on SZSE.

When trading mainland stocks investors can only place limit orders; orders for Shenzhen- and Shanghai-traded stocks must be within the price limit of +/-10% based on the securities’ previous closing price. Buy orders of A Shares must be in board lot of 100 shares, while sell orders can be in odd lots. Currently all Shanghai and Shenzhen-listed stocks are traded in renminbi.


52


Investors are not allowed of conducting day trading of mainland-listed securities. It means A Shares purchased by investors on a trading day cannot be resold before settlement which is on the following business day.

Investors are only allowed to trade on the other markets when both markets are opened.

Investors are unable to trade A Shares on July 1st and June 30th.

Foreign Ownership Limit -Shareholding by a foreign investor through a QFII in a single listed company shall not exceed 10% of the total number of shares of the listed company;

-Aggregate shareholding of A Shares by all foreign investors in a single listed company shall not exceed 30% of the total number of shares of the listed company.

Same as QFII - Shareholding by a foreign investor through a QFII in a single listed company shall not exceed 10% of the total number of shares of the listed company;

-Aggregate shareholding of A Shares by all foreign investors in a single listed company shall not exceed 30% of the total number of shares of the listed company.

Settlement & Clearing T+0 (securities); T+1 (cash) Same as QFII T+0/T+1; SPSA process permits brokers to take a snapshot of the investor’s holdings to conduct pre-trading checks (synthetic DvP and Real-Time DvP are achieved via brokers pre-funding settlement).

Brokerage Services Can appoint up to 3 brokers in Shanghai and 3 brokers in Shenzhen. Although there are a number of brokers covering the two exchanges, these restrictions limit choice and may be an issue around major index rebalances in the event that the primary broker encounters any issues.

same as QFII

Market Cost Fees and taxes applicable to normal A-share trade:

-Securities Management Fee

- 0.00200% of the consideration of a transaction per side (Charged by CSRC)

-Transfer Fee

- Equities: 0.002% on the consideration payable by both

Same as QFII -Handling Fee – 0.00487% of the consideration of a transaction per side (Charged by SSE/SZSE)

-Securities Management Fee – 0.00200% of the consideration of a transaction per side (Charged by CSRC)

Transfer Fee – 0.002% of consideration of a transaction


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the buyer and seller levied by the China Securities Depository and Clearing Corp (CSDC) Shanghai and Shenzhen.

- Bonds: 0.005% is imposed on par value of shares transferred per trade, payable by transferor, with the minimum charged of CNY 10 and maximum of CNY 10000 levied by the CSDC Shanghai and Shenzhen. No charge for Bond Code segment 019 and 020.

-Stamp Duty

- 0.10000% of the consideration of a transaction on the seller (Charged by SAT)

For market cost of CIBM trades, please refer to those specified under CIBM section.

per side (charged by ChinaClear); 0.002% of consideration of a transaction per side (Charged by HKSCC)

Stamp Duty – 0.10000% of the consideration of a transaction on the seller (Charged by SAT)

33.

33

Source: Hong Kong Exchanges and Clearing Limited (HKEx) Website (http://www.hkex.com.hk/eng/market/sec_tradinfra/chinaconnect/Documents/Investor_Book_En.pdf)

http://www.hkex.com.hk/eng/market/sec_tradinfra/chinaconnect/Documents/Investor_Book_En.pdf

FTSE Russell 54

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